Over the past year or so, asset managers, including OppenheimerFunds, have been urging investors to extend their investment horizons around the world. Unfortunately many investors appear to have equated "think globally" with "avoid the United States." For equity portfolios, doing so not only eliminates nearly a quarter of the world's actively traded stocks with over $1 billion in market capitalization, it overlooks some of the very best. So, ever mindful of the ways in which investment opportunities are expanding globally, let's look at what's happening closer to home.
If mutual fund flows provide a window into the retail investor's thinking, domestic equities are an under appreciated asset class. December 2010 was the first month in over two years that more cash flowed into equity than into fixed income funds. The trend has continued into 2011, but while an estimated $153 billion flowed into mutual funds through April of this year, domestic funds actually lost an estimated $79.9 billion. During that same four month period, foreign equity funds attracted over $51 billion. While that pattern may prove appropriate over time, as non-U.S. funds still capture less than 15%of fund holdings, investors may be chasing past returns rather than simply diversifying their risk.
If investors are focusing on postal addresses rather than company fundamentals, valuations should reflect that bias. The chart (above) shows U.S. price/earnings ratios (as measured by the S&P 500) have exceeded international valuations, especially those of emerging markets, for most of the past 20 years. Although today none of these valuations seems excessive, U.S. multiples are below both those of other developed markets and of emerging markets. In fact, on a forward earnings basis, U.S. stocks are more conservatively valued than at any time since the early 1990s.
How dependable are the earnings of U.S. companies? Significantly more so, in my opinion, than in early 2007, when almost 30% of S&P 500 earnings came from the financial sector. Today, the comparable proportion is less than 20%.
Companies in the U.S. have also globalized their thinking. In 2001 less than one-third of S&P sales came from foreign operations. Today, those sales account for nearly one half of the total. What about the half that remains domestic? With consensus annual U.S. real GDP growth estimates for 2011 standing at less than 3% rather than the 6% to 8% expected in rapidly growing emerging economies, domestic sales growth faces challenges. But, cyclically the domestic picture brightens. With monetary policy highly stimulative, and likely to remain so well into 2012, the U.S. business cycle remains in its expansionary phase, however sluggish that expansion may be. In contrast, central banks across emerging markets are actively tightening monetary policy, seeking to slow growth just enough to decelerate inflation without inducing an economic contraction. Sound familiar? Engineering a soft landing challenges the most experienced central banks, but when open markets and rapid growth are recent phenomena, not every economy will succeed.
Over the next cycle U.S. investors will be well advised to look globally to build a portfolio of investment opportunities. In today's market, many of the best opportunities may be closer to home than we think.
Dr. Jerry Webman, Ph.D., CFA, serves as the
Chief Economist at OppenheimerFunds, Inc.
in New York. He provides strategic viewpoints
on the overall financial and economic markets
to the investment management and the
financial advisor and investor communities.
He can be reached at: this email address.